Fintech: Democratising ESG investing

The use of artificial intelligence (AI) has made it easier for retail investors to access investments that adopt environmental, social and governance (ESG) principles. It could provide them with more stable and potentially higher long-term returns, says Omar Selim.

The CEO of Arabesque Asset Management points out that ESG investing used to be costly and only available to a small group of investors. Back then, few financial institutions could afford to hire a team of investment analysts to study ESG-related data and information to assign ratings to public-listed companies. But this is no longer the case, he says.

Nowadays, both large and small financial institutions are able to extract and analyse such data and information using AI, which is cheaper and faster. They can also invest in IT and data experts to automate the ESG scoring and investing process. “Technology is democratising ESG investing,” says Selim.

He adds that technology has enabled financial institutions to rate companies more accurately on their ESG performance by eliminating human bias. Without AI, for instance, an analyst would have to obtain information on a company by visiting its official website and reading up on the policies it has implemented over the years that have benefited society and the environment.

But these marketing materials do not paint the full picture of what the company has done. Some analysts may buy what the company is saying while others may be sceptical. “That is why different analysts have different views and ratings on a company’s ESG score,” says Selim.

However, human bias, which involves personal emotions and perceptions, could be eliminated by using AI. “The technology looks at numbers and news from various data points and searches for patterns [to make an objective assessment],” says Selim.

One advantage of using AI is the ability to tap a larger pool of information and monitor the ESG performance of companies on a daily or monthly basis. An example would be an AI tool that could scan the contents of various newspapers to assess the companies’ ESG scores.

“The policies of some companies may look fabulous online. But if you look at the daily local news, you will find a different picture. You could use an algorithm to screen this news easily even if it is published in different places and in different languages,” says Selim.

Avoiding huge market losses

Selim gives some examples of how he has applied ESG factors to some of Arabesque’s funds, which have outperformed their respective benchmarks (see accompanying story). He points out that the funds managed to avoid huge losses in some stocks by adhering to ESG principles.

A notable example is Facebook Inc’s loss of more than RM130 billion in market value in March, following news that data firm Cambridge Analytica had obtained the personal information of about 50 million users of the social networking service. “We also avoided losses when several stocks plunged in the last three years, including Toshiba and Volkswagen [in 2015 due to financial and emissions scandals respectively],” says Selim.

Toshiba Corp had overstated its operating profit by about US$1.2 billion. Its share price plunged 17% when news of this broke. Volkswagen AG’s stock price plummeted by about 20% when it was discovered that the company had installed software in its cars to circumvent emissions tests.

Arabesque’s ESG screening process played an important part in avoiding these losses, says Selim. While he does not reveal the companies that have scored badly in their ESG ratings, he discloses that Facebook is in the “bottom 25%” of its ESG list.

“It is incorrect to say that we can predict these scandals before they happen. But we can avoid such events more efficiently [and provide investors with a more stable investment performance],” says Selim.

He believes that ESG investing will gain more traction in the future as people’s views on investments change. “They used to think about investment returns first, and philanthropy and charity later. But now, people are thinking of doing both at the same time. They want to invest in companies that have good corporate governance and sustainable business models.”

Selim will be a speaker at the upcoming Global Islamic Finance Forum 2018, which will be held on Oct 3 and 4 in Kuala Lumpur. The event is organised by the Association of Islamic Banking and Financial Institutions Malaysia with the support of Bank Negara Malaysia.

He will address how technology disruption impacts sustainable finance. He will also talk about how Arabesque uses technology to integrate ESG and non-financial data with quantitative investment strategies and how investors can understand the ESG performance of a fund or company in relation to its financial performance.